Trashing Wall Street
To a visitor from, say, Mars, it might come as a surprise to learn that the 1980′s—a decade of stable prices, unprecedentedly low unemployment, and the longest sustained economic expansion in history—were also one of the lowest, greediest, most venal periods in modern American economic history, comparable with the dark era of Reconstruction and the Gilded Age. Yet these are precisely the terms in which the decade is regularly described on the editorial pages of our major newspapers and by the keepers of our conventional wisdom.
The villains of the age just past include the Reagan administration, with its oft-noted fiscal recklessness, and the wizards and cabalists of junk bonds who are accused of having leveraged and pillaged our economy into calamitous hypertrophy. The wickedness is said to be most dramatically encapsulated in one vast, dimly understood misdeed, the savings-and-loan debacle, whose final cost—$300 billion? $500 billion?—is still unknown, but which is far and away the worst financial scandal in U.S. history. Thus, when Michael Milken, the king of junk debt, pleaded guilty this spring to six counts of conspiracy and mail fraud and faced a fine of $600 million and a jail term of up to twenty-eight years, the immediate reaction in many “enlightened” quarters was that he had not been punished nearly enough.
Then, of course, there was Ivan Boesky, the arbitrageur whose trade-up plea bargain ($100-million fine, three-year jail term) was the supposed key to bringing down Milken. There was Dennis Levine, an inside trader whose apprehension and plea-bargaining led to Boesky. There was Milken’s former firm, Drexel Burnham Lambert, a once-puny junk-bond/investment-banking company that had stood Wall Street and corporate America on their ear, only to plead guilty to six counts of misdoing and pay $650 million in fines before going belly-up last February.
The charges against Milken, 98 in all, were brought forward under the Racketeer Influenced and Corrupt Organizations Act (RICO), a jurisprudential weapon originally concocted by Congress in order to attack the Mafia. It was Rudolph Giuliani, the U.S. Attorney for the Southern District of New York and in 1989 a failed candidate for New York City’s mayoralty, who turned RICO into a bludgeon against the investment community. The Act gives to the state the power to confiscate the assets of alleged wrongdoers before their guilt is proven. The single-mindedness, not to say ruthlessness, with which Giuliani exploited this power—as part of the plea bargain with Drexel Burnham, for example, his team demanded that Milken be summarily fired and deprived of his earnings for the year even though he had not yet been found guilty of anything—should form a subject of case-law study for years to come.
The peculiar fact is that the most serious charges against Milken—for insider-trading and racketeering—were dropped in the plea bargain. Therefore, although we know what, under extreme pressure, he pleaded guilty to, we do not necessarily know what he was really guilty of. In economic terms, however, we do know what he did. And that was to identify, encourage, organize, and ultimately orchestrate an enormous new market for corporate debt, a market that is now in a state of collapse.
In 1970, when Milken joined Drexel Burnham at a salary of $25,000 a year, a junk bond was a downgraded security—a promissory note deemed unworthy of its promise. It was hence officially untouchable in the closed circle of underwriters, traders, and institutional investors who have traditionally provided liquidity (otherwise known as cash and credit) to corporate America and to whom only the highest-rated securities have been considered investment grade. Milken’s famed discovery, as a student at the Wharton School of Business, was that the actual risk of default on a non-investment-grade security was considerably less than the assigned risk (as reflected in the high interest rate that the junk bond issuer had to pay). Junk bonds were, in other words, a good deal—if anyone would buy them.
Milken spent the early 70′s promoting his notion, and in the process created a populist rationale for his business: supply-side debt. Those who bought junk bonds would be opening up new sources of income—and growth—for companies that had been excluded from the Wall Street debtors’ club. From the beginning, in other words, there were socioeconomic implications to Milken’s crusade: it was aimed at bringing outsiders in. By no coincidence, Drexel Burnham was at the time one of the less distinguished outsiders in the Wall Street investment-house crowd.
Gradually Milken’s idea caught on—the more so as inflation rates soared and investors had to cast further afield for attractive rates of return. Then came Ronald Reagan, the 80′s, and, even before that, Federal Reserve Chairman Paul Volcker’s use of tight credit to crush inflation, an action which had the incidental effect of depressing stock prices and thereby creating a climate conducive to corporate merger and takeover.
Enter also the U.S. Congress. The Volcker-mandated rise in interest rates, which threw the U.S. into recession in 1980 and 1981, was particularly calamitous for the savings-and-loan industry (S & L’s), the most inefficient, undercapitalized sector of the American financial system—and also the part closest to the voting public. Dowdy institutions that had lent out funds for thirty-year terms at 4 to 8 percent annually suddenly found themselves looking for replacement funds at double the previous cost.
According to most cold-eyed economists, who thought the S & L’s were in need of a shakeout, the fact that many institutions now faced bankruptcy was no bad thing. But the economists did not reckon on the political clout of an industry whose principal product was money. Amid a Reagan-approved deregulation of the financial industry, Congress freed up the desperate S & L’s to invest for the first time in high-risk enterprises, including junk. Congress also approved a doubling of the federal deposit insurance (FDIC) guarantee, from $50,000 to $100,000, ostensibly to protect small investors but by the same token to lure more money back to the S & L’s.
In effect, then, Congress doubled the subsidy for mistakes, bad judgment, and dishonest intent by S & L operators, and doubled the incentive for junk-bond dealers to peddle more and more exotic forms of high-risk paper in a market that had little choice but to demand it. Shysters, high-flyers, and pyramid-scheme artists flocked to the kill—though it must be noted again that most of the S & L operators who helped to fuel the junk-bond market of the 80′s were players in an overprotected industry kept alive by a special-interest-conscious Congress.
In every rising cycle of prosperity and expansion, what works is what goes. Or, as the painter Edgar Degas, born to a banking family, once remarked, “Some forms of success are indistinguishable from panic.” Michael Milken and Drexel were not the first to issue so-called junk bonds—Lehman Brothers, soon to be Shearson Lehman, could claim that honor—but once Milken’s application of the idea caught on, everyone wanted to jump in. Drexel’s and Milken’s problems ultimately stemmed from the fact that they tried, with notable success, to control the market.
Especially the takeover market. Drexel and Milken pioneered in the use of junk bonds in leveraged buyouts (LBO’s). In this maneuver, managers, in partnership with investment bankers, bought up the stock of the companies they worked for, thereby assuming hefty chunks of debt; pruned these companies into more profitable shape; then eventually took their shares back to the stock market for big profits. Initially, LBO’s were friendly, relatively specialized deals, honed in particular by a small firm named Kohlberg Kravis Roberts. What changed all that was the easily accessible pool of money from the rapidly widening junk-bond market. Funds were almost instantly available to do anything, including to outbid reluctant managers for control of their companies. The fees generated for deal-makers and investment bankers by such activity expanded tremendously, as did the potential conflict of interest for these same deal-makers and investment bankers. Once again, the government played a facilitating hand: under IRS rules, the interest on junk bonds used in takeover deals was considered a cost of business, and was tax-deductible.
In 1986, 3,973 takeovers, mergers, and corporate buyouts took place in America. They “cost” $236 billion, mostly in the form of debt. At that level of activity, all the traditional corporate citadels of America could—and did—feel besieged. And there was really no one else to focus on but Milken, whose control of the junk market was truly masterful, on a level, perhaps, with the control exercised by the great trust-builders of the late 19th century. Outside of rarefied financial circles, however, very few people have ever understood what goes on in securities markets anyway. They seem specialized, complex, and breathtakingly arcane, and at the same time stupid, brawling, and vulgar. The kind of money sloshing around in those markets—and the percentages that could cling to even relatively minor hands—created its own kind of hypnosis, not to mention envy. The forces that actually made the markets work were largely invisible (as Adam Smith might have observed), and rational only in their apparent irrationality. What could be seen was the stuff of journalism and innuendo.
Unfortunately, the visible is almost all one gets in most of the popular books that have poured out, junk-bond fashion, following the scandals of the last eighteen months. Readers can gain a great deal of vicarious enjoyment, for instance, though not much enlightenment, from Barbarians at the Gate by Bryan Burrough and John Helyar.1 This is a detailed and intriguing recapitulation of the 1988 hostile takeover of RJR Nabisco by Kohlberg Kravis Roberts—which, by its size, has become a metaphoric representation of all 80′s real and imagined greed and folly.
The symbolic presence here is that of Ross Johnson, an amiable, golf-loving Canadian marketing man who ascended to the top of the merged and remerged food-and-tobacco giant, then committed corporate seppuku when he tried to organize an LBO of the company. Johnson’s real forte, as the authors show, was corporate politics, and he was especially good at narcotizing his boards of directors with goodies dipped from the company’s bounteous cash flow. Johnson’s personal perks have become justly famous: the professional golf buddies paid as consultants, the immense corporate air fleet and houses alongside Florida golf courses. Altogether, this is a story that goes far toward proving a charge made frequently by one of the most successful corporate raiders, Carl Icahn: modern American corporations are inefficient, run indulgently in favor of incumbent management, and immune to shareholder pressure.
Burrough and Helyar present the battle for control of RJR as a contest between a blundering Peter Cohen, Johnson’s main investment banker (and, until his recent resignation, president of Shearson Lehman), and a tougher, smarter Henry Kravis, whose desire to win eventually caused him to toss in a bid that the cruel marketplace was by then signaling as too high. Cohen eventually paid for his hubris with his job. As for Kravis, some of his elaborate securities packages are now showing severe signs of strain.
At bottom, however, Barbarians is a variation on standard, behind—the-scenes political reporting, colored as much by the selective revelations of sources as by the reporters’ own judgments. In the end, the authors settle for the idea that the battle for control of the company was an illustration of nothing more than human folly and vanity. RJR Nabisco, they say, “became a vast prism through which scores of Wall Streeters beheld their reflected glories.” Well, maybe, but so what?
In True Greed, Hope Lampert2 provides an even more prosaic view of this allegedly revelatory takeover battle. Her jargon is numbing—“Shearson had proposed a three-year reset on the preferred PIK, and Stern was not keen to adopt Rinaldi’s one-year”—and her conclusion, a perfectly safe one, is that the future of the LBO does not look good.
RJR is blessedly absent from Circus of Ambition,3 but so is almost everything else. Its author, John Taylor, has attempted to sew together a number of ideas for magazine articles linking the Reverend Jerry Falwell; a twenty-seven-yearold stock-market hustler named Charlie Atkins; a rude, ambitious, and apparently untalented artist; and a variety of other ambiguous characters into a paradigm of the age. Although the book’s prose has bizarre amusement value (“The grasping materialism of the Gilded Age, which began after the Civil War and replaced the Jeffersonian political idealism that marked the first seventy years of the nation’s history, dominated the country from 1865 to 1929—a little more than half a century”), the only point, insofar as one can be discerned at all, is that the economic history of the United States consists of periods of grasping manipulation, jiggery-pokery, and selfishness interspersed with depressions and rare, golden moments when a certain redistribution of income takes place. Whatever capitalism, industry, technology, or finance may be, Taylor does not want to know it.
Michael Lewis, on the other hand, cheerfully admits in Liar’s Poker4 that, as a fledgling bond trader at Salomon Brothers, he knew nothing about what he was doing. Nor, as a participant in the “Animal House” culture at Wall Street’s preeminent bond-trading firm, did he need to; the aim of bond traders at Salomon’s, he reveals, was to fleece unwary customers, make millions, and become what was known in-house as Big Swinging Dicks. The aim of every other trader elsewhere, presumably, was to do the same back.
Lewis’s more serious point in an often hilarious book is that the sheer volume of money running through the financial markets in the 80′s brought a distortion of judgment that led his firm to overextend itself, so that by the end of the decade it was left wallowing like the rest of Wall Street. Refreshingly, however, Lewis does not believe that the sometimes destructive dynamics of capitalism must be explained in terms of a dark driving force (such as “greed”) peculiar to the Age of Reagan; rather, those dynamics are inherent in the system itself, and account for its stupendous creativity as well as its excesses.
Hints of demonic or conspiratorial economic forces have, of course, been a fixture since the modern capitalist age began. One particularly ugly aspect of that persistent view surfaced last year in connection with the observable fact that Ivan Boesky, Michael Milken, and many of the other alleged financial malefactors of the 80′s were Jewish.
The issue is openly joined in the novel Hanover Place by Michael Thomas,5 a former merchant banker and now a columnist for the weekly New York Observer. The book, a ponderous historical saga, traces the rise and decline of a Wall Street investment firm known as Warrington & Co., a Wasp bastion that eventually falls into the hands of upstart and shady Jewish financiers.
In a review of Hanover Place in the New York Times Book Review, Judith Martin (better known as Miss Manners) charged Thomas with suggesting that anti-Semitism was the fault of Jews themselves. The incident in the novel to which Miss Martin pointed concerns a group of raiders, led by a Jew, who are warned by a prominent European Jewish banker to cease and desist from their activities lest they provoke anti-Semitism. His plea is ignored, and the worst happens.
From his weekly platform in the Observer, an indignant Michael Thomas denied Miss Martin’s allegation: “. . . just as you must have hydrogen combined with oxygen to make water, to watch the vile flame of anti-Semitism spring into being, you must have enviable Jewish success and enviable Jewish identity to combine with non-Jewish discontent, frustration, anger, resentment, insecurity—there are a hundred strains of malignancy to choose from.”
An equivocal statement, to say the least. But as for the “hundred strains of malignancy,” Hanover Place certainly puts a lot of them on display: the novel unquestionably contains some of the most sustained expressions of anti-Semitic sentiment to appear in a long time. Nearly all of those expressions are, it is true, placed in the mouths of bad, weak, depraved, or deprived individuals. And in careful contradistinction to them stand the novel’s chief protagonists, Fletcher and Lyda Warrington. Thus, we are told, Lyda “despised anti-Semitism, at least she despised it institutionally, which was the only form in which she’d experienced it”; a Warrington partner is pushed out of the firm because of his rabidly anti-Semitic views; and an attempt to block the progress of the firm’s brilliant Jewish analyst, Morris Miles, is solidly rebuffed.
But all this, in a novel that moves from 1924 to the present, is prelude. For by the 1970′s the son of the faithful Morris is scheming to take over the firm, and eventually succeeds. One of his backers launders drug money. The brains of the new firm belong to a genius named Arthur Lubloff, the aforementioned proponent of hostile takeovers who creates “a complex interleaved structure of debt-creation and interaction that only he understood, and to which he was universally regarded as indispensable.” Soon after his death in a plane crash, world financial markets crash, LBO-related bankruptcies occur, the dollar collapses, and anti-Semitic outrages spread across the country.
What, then, is the meaning of this leaden cautionary tale? It is that proper bounds must be observed. Thomas, an old-style American Tory, believes in a world that is a profoundly ordered place, with the Wasp naturally, and unspokenly, at its center. Though his protagonists reject anti-Semitism “institutionally,” that is to say as a doctrine, they also reject anyone who tries to push into their clubs or to break the Wall Street code as they know it. The crime committed by the “bad” Jews in Thomas’s novel is the failure to understand, and appreciate, their proper place. Thomas has repudiated the idea that this amounts to anti-Semitism; perhaps he is right. Perhaps it is, instead, a highly idealized expression of apartheid.
So where does all this introspection leave the 80′s, the decade of unsurpassed “greed” and “folly”? The evidence, sometimes inadvertent, of each of these books is that they were an exceptionally exciting and creative, as well as venal, time on Wall Street, and also that they were a time when the laws of oversupply (of credit) and demand were not suspended. What is largely missing is a consciousness of the relationship between boom and bust in capitalist economics—perhaps because Reaganomics sheltered us all from such knowledge for so long. For the rest, these books largely ignore, misapprehend, or downplay the absolutely crucial role played by a liberal Congress in first propping up, then double-crossing, the thrift industry, and accelerating the worst tendencies of the age. And most of them miss entirely the accumulation of talent and energy in the traders and raiders whose activities they more or less piously deplore.
There have always been those who have condemned the workings of capitalism as a kind of fraud. And many are those who are proud to be offended by the Age of Reagan. These books still leave room for an intelligent effort to understand the two phenomena, especially in conjunction.
1 Harper & Row, 528 pp., $22.95.
2 NAL Books, 259 pp., $18.95.
3 Warner Books, 240 pp., $12.95.
4 Norton, 249 pp., $12.95.
5 Warner Books, 479 pp., $19.95.